Wednesday, September 2, 2009

Société Générale's Albert Edwards "A Full Blown Deflationary Episode"

It is a month since we last heard from the Soc Gen strategist and he is in typically combative form in his latest Global Strategy Weekly. Indeed, he has a very simple message for all those commentators puzzled by the fact that both government bond and equity markets are rising — don’t be.

The bond market is responding to two key events. First, it is clear to us the ongoing march into outright deflation will accelerate during this short-lived economic recovery. Second, post-bubble realities will force commercial banks to aggressively step up their buying of government bonds.

To wit he notes:

In the US and elsewhere, where commercial bank exposure to government paper is still close to all-time lows, the unwinding of grotesque over-exposure to bubble sectors like real estate will continue to underpin the secular bull market in government bonds.

As for equity investors, well they are just short sighted:

Once again, equity participants are missing the big picture. Despite clear signs from the business surveys of some sort of H2 recovery, firm evidence is emerging that the global economy is sliding towards a full-blown deflationary episode once this recovery falters.

While there can be no doubt that survey evidence is pointing to a more robust second half, equity markets should be far more nervous than they currently are. We heartily concur with GMO’s Jeremy Grantham who remarked recently that after 20 years of more or less permanent overvaluation of US equities, we saw just five months of under-pricing through the March trough. Do bursting global equity valuation bubbles really end like this? Of course they don’t.